Author: Karl Whelan

New Projections of Interest Rates on EU Loans

The topic of the interest rate on Ireland’s EU loans has attracted a lot of attention. Unfortunately, however, hard information on the loans and comparisons with the loans being offered to Portugal is not always easy to come by. The purpose of this post is to provide the information that is publicly available on this issue and to present new calculations of the likely interest rates on Ireland’s loans.

The most common media reference point for the cost of Ireland’s loans is this information note released by the NTMA in November. That document projected the cost of Ireland’s loans from the European Financial Stability Mechanism (EFSM) at 5.7 percent and the cost of Ireland’s loans from the European Financial Stability Facility (EFSF) at 6.05 percent.

With €22.5 billion being provided to Ireland by the EFSM, €17.7 billion by the EFSF and €4.8 billion coming from bilateral loans, the NTMA note assumed the interest rate on the bilateral loans would be the same as the EFSF rate. Thus, the estimated average cost of the EU loans was 5.875 percent. (I am leaving aside in this note the question of the cost of funding from the IMF, which is determined according to standard, if somewhat complex, IMF procedures.)

In a briefing note for the Oireachtas Committee on European Affairs, I noted that market interest rates had risen since the November briefing and the pricing of the first EFSM bond had not gone as well as anticipated. Based on those considerations, I suggested that the cost of EFSM funding was likely to be 6.09 percent while the cost of EFSF loans would be 6.44 percent.

The period since that briefing note was written has seen a number of EFSF and EFSM bonds issued to Ireland and Portugal, so now seems like a good time to attempt to get a more accurate picture.

Here’s a link to a spreadsheet that describes each of the bonds issued by EFSF and EFSM as well as the conditions on which they were disbursed to Ireland and Portugal. I have made estimates of what the interest rates will be on funds that are not yet drawn down by assessing their likely average maturity (to match the planned 7.5 year average maturity for Ireland and Portugal), calculating current market interest rates for those maturities (based on the mid-swaps benchmark used by the EFSF and EFSM) and then adding in the estimated margins.

A quick summary:

1. The average interest rate on EFSM loans for Ireland is projected to be 6.13 percent.

2. For Portugal, the EFSM loans project to have an average interest rate of 5.34 percent. The lower rate than for Ireland is because the EFSM’s profit margin on Portuguese loans is 77 basis points lower than for Ireland.

3. The average cost of EFSF loans for Ireland is projected to be 6.29 percent. This is lower than I had estimated in January because I had used the assumption underlying the NTMA’s November document that the margin over funding cost that would determine the effective borrowing cost for Ireland would be 317 basis points. Based on the one EFSF bond issue for Ireland so far, I now estimate that this average margin will be 305 basis points.

4. The average cost of EFSF loans for Portugal is projected to be 5.76 percent.

5. Based on the assumption that Ireland’s bilateral loans (not yet drawn down) will carry the same average interest rate as the EFSF, the average interest rate on Ireland’s EU loans will be 6.21 percent, 33.5 basis points higher than estimated last November. The average interest rate on Portugal’s EU loans is projected to be 5.55 percent, 66 basis points lower than the projected rate for Ireland. 

6. The current terms on Greece’s EU-IMF loans have been widely reported to be 4.2 percent for a 7.5 year average maturity after Greece was granted a 100 basis point reduction at the March 11 meeting of the Heads of Government of the Euro Area member states.

For those interested, here’s a rough description of how the calculations were done.

Continue reading “New Projections of Interest Rates on EU Loans”

Professor Sinn Doubles Down

I know this is getting silly now and everyone knows what’s going on with the Target 2 debate. Still, it’s entertaining to see Professor Sinn doubling down on his false claims about the operation of the Eurosystem.

By the end of 2010, ECB loans, which originated primarily from Germany’s Bundesbank, amounted to €340 billion.

Em, no. I don’t know how to explain this any better than here. But, like I say, really, honestly, no.

But, he’s on a roll now is Professor Sinn, so now we get a new nonsensical talking point:

If this continues for two more years as it has for the past three, the stock of refinancing loans in Germany will disappear altogether.

Indeed, Deutsche Bank has already stopped participating in refinancing operations. If German banks drop out of the refinancing business, the European Central Bank will lose the direct control over the German economy that it used to have via its interest-rate policy. The main refinancing rate would then only be the rate at which the peripheral EU countries draw ECB money for purchases in the center of Europe, which ultimately would be the source of all the money circulating in the euro area.

I literally laughed out loud when I read this. So Deutsche Bank don’t borrow from the ECB? Who cares? There have always been banks with surplus liquidity and banks that are short of liquidity. That’s why interbank money markets exist.

The fact that the ECB stands willing to make unlimited amounts of short-term loans to all Euro area banks at 1.25% is clearly the key influence on short-term rates throughout the Euro area.  Deutsche Bank may not be borrowing from the ECB but they certainly won’t be able to lend their funds out on a short-term basis at rates that are much higher than the ECB’s.

So ECB rates are clearly setting German short-term interest rates just as they set them elsewhere in the Euro area. (Note also the resemblance between ECB rates and short-term German government bond yields.)

So another scary sounding but ultimately baseless claim from Professor Sinn.

Seamus Coffey on the Savings Rate

One of the point that has been made repeatedly about the Irish economy over the past year or so is that weak domestic demand is connected with a high savings rate. (Admittedly, the actual national income data on personal savings rates are only available with a long lag but the slow pace of consumption spending is consistent with this story). Many, including now Minister Noonan, put this increase in the savings rate down to discretionary precautionary savings and believe that once people relax about their future, domestic demand will take off again.

I’ve always been pretty skeptical of this argument. My take on spending patterns has been that the increase in the savings rate may be more connected to people who had previously been able to live beyond their means having to pay back debt because of the change in financial market conditions, while others who have always saved continue to do so.

The implications of this story for the future evolution of the savings rate are quite different. There is little reason to think those who have been saving all along (e.g. for retirement) will reduce their propensity to do so. Indeed, if they were reliant on their funds invested in Irish property or in Irish pension funds now subject to the new levy, then the opposite would be the case. And those who are apparently saving because they are re-paying debt are, in practice, feeling as if every euro they earn is earmarked for either debt repayment or managing to keep going. These people are also unlikely to suddenly start spending if the economy stabilises.

Anyway, I’ve meant to make that point on this blog loads of times but didn’t. Then Seamus Coffey wrote this excellent post and, in comment speak, I want to say “What he said.”

New Data on Loans and Deposits

The Central Bank has continued its excellent work in making more statistical data available with two new releases “Trends in Business Credit and Deposits” and “Trends in Personal Credit and Deposits“. I don’t have time to get into a detailed discussion of these releases but, on a quick look, there appears to be lots of new and interesting information in these releases.

Anglo Debt: Nods, Winks and Blind Horses

For the latest update on the government’s position on Anglo debt, I recommend this post from NAMA Wine Lake.